IRA Alert

New rules permit plan balance shift

IRS has created opportunities for beneficiaries to convert to Roth IRAs, with restrictions

Mar 31, 2008 @ 12:01 am

By Ed Slott

Providing guidance on the provision of the Pension Protection Act of 2006 that now allows a plan participant to convert a plan balance directly to a Roth IRA, the Internal Revenue Service has issued a set of new rules (Notice 2008-30).

In some cases, after-tax funds from 401(k), 403(b) and 457 plans can be converted to a Roth individual retirement account tax-free, as long as only those funds are converted and the remaining plan funds are rolled into a traditional IRA.

The Roth conversion eligibility rules still apply, meaning that a taxpayer's modified adjusted gross income cannot exceed $100,000, whether filing a joint or a single return, and the taxpayer cannot be married filing separately. Until Jan. 1, 2010, when these rules are repealed, everyone converting funds to a Roth IRA must comply.

The new rules contained a completely unexpected provision: They allow a non-spouse plan beneficiary to convert an inherited plan balance to an inherited Roth IRA. To be eligible for the post-death Roth conversion, non-spouse beneficiaries must meet the same MAGI and filing status requirements as plan participants.

The transfer must be direct. If a direct transfer does not take place, and the beneficiary receives a distribution of inherited plan assets payable to her (a 60-day rollover), she will not be able to roll those assets into an inherited IRA, traditional IRA or Roth IRA. She also will owe taxes on the distribution and will have lost the stretch opportunity.

Roth IRA owners are not subject to required minimum distributions, but non-spouse Roth IRA beneficiaries are. After converting the inherited plan assets to an inherited Roth IRA, the beneficiary will have to take RMDs from the inherited Roth. This could make doing a Roth conversion of inherited assets less attractive, unless the beneficiary is young.

Given this drawback, should non-spouse beneficiaries pay the tax to convert an inherited employer plan asset to an inherited Roth IRA? That depends on whether they can get past these initial hurdles:

1. The employer plan must allow a non-spouse beneficiary to do a direct rollover in to an inherited IRA.

2. Beneficiaries must meet current Roth conversion qualifications.

3. Beneficiaries must be able to pay the income tax due with funds outside of the inherited Roth IRA.

Only beneficiaries clearing these hurdles will be able to reap the benefits of this provision. Since a trust is a non-spouse beneficiary, a trust that is the plan beneficiary also can take advantage of the new rules, although there are several unanswered questions about the mechanics of how trusts would qualify.

Although an IRA beneficiary cannot convert an inherited IRA to a Roth IRA, under this quirk in the Internal Revenue Code, plan beneficiaries can.

If a beneficiary has the option of converting his own IRA or inherited employer plan assets to a Roth IRA, the former alternative makes more sense because by doing so he would have no RMDs during his lifetime and at his death his spouse could inherit the Roth, then roll it over to her own Roth and continue deferring RMDs. The owned Roth IRA would have many years to grow and compound on a tax-free basis before non-spouse beneficiaries are re-quired to take RMDs.

If limited funds are available to pay the income tax and the beneficiary has his own IRAs, the funds are probably best used to first convert his own IRA funds to his own Roth IRA. Life insurance also should be looked at as a source of tax-free, post-death cash to pay the beneficiary's conversion tax. The beneficiary also might have inherited other non-IRA funds from which the conversion tax could be paid.

If the plan participant truly wants his beneficiaries to be able to get the greatest advantage of the Roth IRA, the best overall option would be to convert his own company plan funds or traditional IRA funds to a Roth IRA during his lifetime. That way the Roth IRA can grow many years free of RMDs, and eventually be inherited by the beneficiary income tax-free. If the plan beneficiary converts the inherited plan funds, all earnings up to that point will be taxed at conversion time. The sooner a plan or IRA is converted to a Roth IRA, the better, since all future growth will escape income tax forever.

Ed Slott, a certified public accountant in Rockville Centre, N.Y., has also created The IRA Leadership Program and Ed Slott's Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace. He can be reached at

For archived columns, go to


What do you think?

View comments

Recommended for you

Upcoming Event

May 16


Chicago Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video


Why millennial demand for ESG is falling on deaf ears

Editorial director Fred Gabriel and senior columnist Jeff Benjamin say there's a disconnect between the big appetite for environmental, social and governance funds in 401(k) plans and their offering.

Latest news & opinion

Blucora to buy another broker-dealer with tax-focused advisers

Blucora is paying $180 million in stock for 1st Global, with 850 advisers.

Finra panel dismisses $100 million case involving drop in Merrill Lynch stock

Former brokers bringing charges related to stock losses during financial crisis have had 15 cases proceed, four stopped so far.

Principal-Wells Fargo retirement deal would be among largest ever

Acquisition would be in line with trend of record keepers seeking to gain scale to combat fee reduction.

Finra panel dismisses $100 million case involving drop in Merrill Lynch stock

Former brokers bringing charges related to stock losses during financial crisis have had 15 cases proceed, 4 stopped so far.

ESG options scarce in 401(k) plans

There's growing interest among plan participants, but reluctance to add funds that take into account environmental, social and governance factors persists.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print